Chapter 1: Introduction
Bank of England independence
1.The Bank of England was granted operational independence in 1997. This followed periods of high inflation in the 1970s and 1980s. By the 1980s, controlling inflation had become the overriding objective of UK monetary policy.1 Departure from the Exchange Rate Mechanism in September 1992 meant that a new domestic policy framework to control inflation was required, and the inflation target was announced in October 1992. After independence, the Bank of England’s Monetary Policy Committee—the body in the Bank of England tasked with setting monetary policy—was given a mandate, consisting of a primary objective to meet an inflation target of 2% in the medium term set by the Chancellor,2 and a secondary objective to support the Government’s general economic policy. The inflation target is symmetric, which means the Bank of England is responsible for returning inflation to target from below 2% as well as from above. If the rate of inflation moves away from the 2% target by more than one percentage point in either direction, the Governor of the Bank of England is required to write to the Chancellor to explain what action the Monetary Policy Committee will take in response.3
2.Power to set the official interest rate (known as Bank Rate)—which is used to meet the inflation target—was transferred from the Chancellor to the Monetary Policy Committee. Independence from political concerns, combined with clear and widely understood objectives, is thought to lead to more effective monetary policy.4
3.The independence of the Bank of England contributed to an economy characterised by moderate inflation and consistent expansionary growth. However, that period of stability ended with the global financial crisis in 2007–08, which shocked the financial systems of Europe and the US and led to a global recession along with sustained low inflation and weak economic growth. In many countries, the challenge for central banks shifted from reducing inflation to raising it. Central banks across the world, including the Bank of England, responded by cutting interest rates to record low levels and introducing an unconventional monetary policy called ‘quantitative easing’.
What is quantitative easing?
4.Quantitative easing is a monetary policy tool that central banks can use to inject money into the economy through the purchase of ‘financial assets’, usually government bonds.5 Quantitative easing is also known as ‘asset purchasing’.6
5.Usually, when an economy is slowing down or entering a recession, central banks will cut interest rates to make borrowing and investment—which help to create economic growth—cheaper. However, in circumstances in which a central bank has already lowered interest rates close to 0% (known as the ‘zero lower bound’), quantitative easing has been used with the intention of stimulating spending, investment and growth.
6.Whenever the Monetary Policy Committee decides that it needs to undertake additional quantitative easing, the Bank of England creates new money to purchase Government or corporate bonds from private sector entities, such as pension funds or insurance companies. Once the Bank of England has purchased bonds from, for example, a pension fund, the pension fund receives new money in the form of a deposit in a commercial bank. The commercial bank has the deposit (a liability to the pension fund) and additional interest-paying reserves—a type of money that commercial banks use to pay each other—in the Bank of England (an asset).7
7.The Bank of England expects these actions to have effects that will boost the economy. These effects are sometimes referred to as ‘transmission mechanisms’ and they include:
- Portfolio rebalancing: by buying large amounts of Government bonds, quantitative easing pushes up their price and lowers their interest rate for investors. Because interest rates on Government bonds tend to affect other interest rates in the economy, the Bank of England hopes that this will lower long-term interest rates offered on other loans, such as mortgages or business loans, making it cheaper for businesses and households to borrow and spend money. When investors sell assets to the Bank of England, their bank accounts are credited with the proceeds which provides liquidity. Some, or all, of that new money will be spent on purchasing a range of financial or real assets, such as shares or property, thus raising their price. Those higher asset prices should stimulate spending, either directly or by lowering the cost of financing new investment.
- Signalling: by purchasing bonds, the Bank of England in effect signals to the financial markets and lenders that it will keep interest rates low for a longer period of time. This reduces long-term interest rates in the economy and provides some certainty to banks that people can afford to borrow money.
- Market liquidity: by buying Government bonds, the Bank of England reassures investors that they can sell these bonds if they wish. That makes them a safe asset to hold and reassures investors that they will be able to access liquidity by selling them even when financial markets are in distress.
- Wealth effects: quantitative easing can boost a range of financial asset prices, such as bonds and shares. This increases the value of these assets, which makes businesses and households holding them wealthier. The Bank of England hopes that this makes them more likely to spend money on goods and services, which would boost economic activity.
Figure 1: Quantitative easing transmission mechanisms
Source: Bank of England, Staff Working Paper No. 899, The central bank balance sheet as a policy tool: past, present and future, (December 2020): https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2020/the-central-bank-balance-sheet-as-a-policy-tool-past-present-and-future.pdf [accessed 6 July 2021]
Global context
8.In the 1980s and early 1990s, Japan experienced a stock and land market bubble which burst, leading to a financial crisis culminating in a threat to the solvency of the banking system in the late 1990s. Japan then experienced a period of economic stagnation and deflation (falling prices which may harm growth and employment), which led the Bank of Japan to cut interest rates.
9.In 2001, the Bank of Japan announced its first round of quantitative easing, which was intended to tackle deflationary pressures and to boost the amount of money held by commercial banks to help them to absorb losses from bad loans following the financial crisis in the 1990s. The Bank of Japan launched further rounds of quantitative easing over the last decade, initially in response to the global financial crisis, and most recently to support the economy through the COVID-19 pandemic.
10.The Bank of Japan was an outlier in its use of quantitative easing until the 2007–08 global financial crisis. It still is in terms of the total value and type of assets that it has purchased. Nevertheless, since the global financial crisis, quantitative easing has been used in many other large economies, including the US and the Eurozone. The US Federal Reserve introduced asset purchasing in response to the financial crisis in 2008, which it expanded in 2010 and 2012 to support economic stabilisation and recovery. In 2013, the Federal Reserve announced a ‘tapering’ of asset purchases, which were eventually stopped in 2014. It reduced its asset holdings again in 2017 but this ended in 2019. In 2020, in response to the economic crisis that resulted from the COVID-19 pandemic, the Federal Reserve announced ‘open-ended’ asset purchases, including corporate bonds.
11.The European Central Bank started purchasing assets in response to the 2008–2012 financial and sovereign debt crises. Between 2014 and 2019, it continued to purchase a range of assets to support monetary policy objectives and to provide additional stimulus. In 2020, in response to the COVID-19 economic crisis, it launched a temporary Pandemic Emergency Purchase Programme, which expanded the eligibility criteria for asset purchases.
12.On 26 February 2021, Andy Haldane, the Bank of England’s outgoing Chief Economist, said central banks have expanded their balance sheets by $10 trillion, or 13% of global GDP, since the financial crisis and by approximately $5.5 trillion since 2020, in response to the economic crisis that resulted from the COVID-19 pandemic. Figure 2 sets out the expansion of the balance sheets of several central banks since 2006.
Figure 2: Selected central bank balance sheets (US Federal Reserve, European Central Bank, Bank of Japan, Bank of England and
Swiss National Bank)
Source: Andy Haldane, speech on Inflation: A Tiger by the Tail?, 26 February 2021, p 9: https://www.bankofengland.co.uk/-/media/boe/files/speech/2021/february/inflation-a-tiger-by-the-tail-speech-by-andy-haldane.pdf [accessed 5 July 2021]
Quantitative easing in the UK
13.In the UK, quantitative easing was envisaged, at the point of introduction in 2009, as a short-term measure to support the economy through the global financial crisis. However, over the last decade or so, the programme has expanded substantially, and it has become the Bank of England’s main monetary policy tool.
14.The Bank’s quantitative easing programme can be split into three broad phases. The aim of the first phase, between 2009 and 2012, was to boost nominal spending and to provide liquidity to banks and financial institutions during the financial crisis.8 In this period, the Bank conducted seven rounds of quantitative easing, totalling £375 billion by July 2012.9
15.The second phase, from August 2016, was a response to market uncertainty following the UK’s vote to leave the European Union. Bank Rate was cut to 0.25% and the Bank of England expanded its quantitative easing programme with a further £70 billion of asset purchases, including £10 billion of corporate bonds. The Bank of England said that asset purchases would trigger market participants to “rebalance” their investments into riskier assets, and this would lower “the real cost of borrowing for households and companies.” Its corporate bond purchases were designed to encourage those selling corporate debt to reinvest in other corporate assets.10
16.The third phase of quantitative easing, which was by far the largest, was launched in response to the COVID-19 pandemic. The Bank of England announced three rounds of asset purchases in March, June and November 2020, totalling £450 billion in Government bonds and a further £10 billion in non-financial investment-grade corporate bonds—around double the number of assets purchased in the first two phases of quantitative easing combined. The Bank expects to complete bond purchases by the end of 2021. It said that all three rounds were designed to help it to meet its inflation target. It said to meet this objective, the March 2020 round of quantitative easing was designed to support the gilt market and the subsequent two rounds were to support the economy.11 Not only has the Bank of England purchased substantially more assets in this phase, it has done so against a highly expansionist fiscal policy.
Figure 3: Bank of England QE programmes and selected policy interventions since 2009
Source: Bank of England, ‘IEO Evaluation of the Bank of England’s approach to quantitative easing’, 13 January 2021: https://www.bankofengland.co.uk/independent-evaluation-office/ieo-report-january-2021/ieo-evaluation-of-the-bank-of-englands-approach-to-quantitative-easing [accessed 6 July 2021]
17.In total, the Bank of England will have bought £875 billion of Government bonds and £20 billion of corporate bonds, totalling £895 billion in assets by the end of 2021. Figure 4 sets out how the value of assets purchased by the Bank of England has grown since 2009.
Figure 4: Bank of England bond purchases by the month that new purchases were announced
Source: Bank of England, ‘What is quantitative easing?’: https://www.bankofengland.co.uk/monetary-policy/quantitative-easing [accessed 6 July 2021]
Figure 5: Bank of England balance sheet as a percentage of GDP
Source: Dave Ramsden, speech on QE as an economic policy tool - what does it do and how should we use it?, 17 February 2021: https://www.bis.org/review/r210303k.pdf [accessed 6 July 2021]
18.Quantitative easing in the UK now totals around 40% of GDP. The Bank of England is not alone in substantially increasing its rate of quantitative easing. The quantitative easing programmes in the US, Eurozone and Japan now total around 30%, 32% and 106% of GDP respectively.12
Our inquiry
19.The role and economic influence of the Bank of England has grown substantially since the global financial crisis, as have expectations that it will intervene in periods of economic uncertainty.13 The trend for interventionist monetary policy continued during the COVID-19 pandemic, and led to the doubling of the UK’s quantitative easing programme.
20.We launched this inquiry at this juncture for several reasons. First, the quantitative easing programme has not been subject to sufficient scrutiny, including in Parliament, given its size, longevity and economic importance. The increased role of the Bank of England in the economy merits enhanced accountability by Parliament.
21.Second, the substantial escalation of quantitative easing during the COVID-19 pandemic was unprecedented. While we recognise that the Bank of England was acting quickly in response to an economic emergency, it is imperative that the Bank is held accountable and asked to explain the reasons for its decisions openly and in sufficient detail. The importance of this was emphasised during the inquiry as it became apparent that there was a widespread perception that the Bank of England had conducted quantitative easing primarily to support Government borrowing rather than for monetary policy purposes, and that this perception might have been strengthened as a result of poor communications.
22.Third, we wished to examine the extent to which quantitative easing has achieved its stated objectives, along with its effects on the real economy, growth and inflation. Quantitative easing is widely considered to have exacerbated wealth inequalities as it raises the price of certain assets, benefiting those who own them. Some consider this effect on asset prices to be responsible for risky behaviour in the financial markets and for inflating speculative bubbles. Moreover, the scale of the increase in asset purchases by the Bank in 2020–21, and the consequent rapid increase in broad money, has fuelled concerns that inflation may start to pick up faster than the Bank currently expects.
23.Fourth, we wanted to examine the most significant risks to the public finances that might result from quantitative easing, given that the Bank of England now holds a substantial portion of the debt issued by the Government. We heard that the threat of rising inflation, as the economy starts to recover, exposes Government debt to higher servicing costs if the Bank of England were to raise interest rates. We were told that this could expose the Bank of England to political pressure.
24.Fifth, we wanted to find out the Bank of England’s plans for quantitative easing in the future. The programme has become significantly larger and more persistent than the Bank envisaged in 2009 when it was introduced, and it has taken no steps to reduce the size of its balance sheet. We therefore wished to hear from the Bank of England on its plan for unwinding quantitative easing and its preparations for the next economic crisis.
25.Many of our motives for this inquiry stem from a concern that quantitative easing is eroding the operational independence of the Bank of England or is at least creating the perception of this. Before we launched our inquiry, Andy Haldane, the Bank of England’s outgoing Chief Economist, recognised many of the same issues that are growing in importance as the Bank’s balance sheet grows. He said:
“Recent quantitative easing has placed central banks in deep, and uncharted, waters. My view is that these quantitative easing actions have been necessary to support the economy and hit the inflation target. But they pose rising challenges to public understanding of the purposes of quantitative easing and, ultimately, perceptions of independence.”14
26.If the perception that the Bank of England has lost its operational independence takes hold, or that it is taking decisions on the basis of political considerations, we heard that the effectiveness of its monetary and financial stability policies would be undermined.
27.This would reduce the Bank of England’s ability to influence inflation and maintain financial stability, which would have negative consequences for all of us.15
28.While the UK can be proud of the economic credibility of the Bank of England, this credibility rests on the strength of the Bank’s reputation for operational independence from political decision-making in the pursuit of price stability. This reputation is fragile, and it will be difficult to regain if lost. So far, the Bank—and indeed other central banks which have used quantitative easing—have retained the confidence of international markets.
Witnesses and evidence
29.In this inquiry we took oral evidence from prominent monetary policy practitioners and experts. We would like to thank in particular those witnesses from overseas who gave us the benefit of their knowledge and experience, including Masaaki Shirakawa, the former Governor of the Bank of Japan, Otmar Issing and Peter Praet, former Chief Economists of the European Central Bank, Kenneth Rogoff, Professor of Economics and Thomas D. Cabot Professor of Public Policy at Harvard University, Adam Posen, President at Peterson Institute for International Economics, Stephen G. Cecchetti, Rosen Family Chair in International Finance at Brandeis International Business School, and Christina Parajon Skinner, Assistant Professor of Legal Studies & Business Ethics at The Wharton School of the University of Pennsylvania, along with many others.
30.We took evidence on quantitative easing from academics and think tanks from the UK, Europe and the US, as well as evidence from representatives of the UK financial sector. We are also grateful to those members of the current and former leadership of the Bank of England and HM Treasury who contributed to our inquiry. A full list of witnesses and authors of written submissions is available in Appendix 2.
31.Finally, we would like to thank our Specialist Adviser for this inquiry, Professor Rosa M Lastra, Sir John Lubbock Chair in Banking Law at Queen Mary University of London.
1 Prices rose by 750% in the 25 years to 1992, more than over the previous 250 years. See Mark Carney, speech on Independence – 20 years on, 28 September 2017: https://www.bankofengland.co.uk/-/media/boe/files/speech/2017/opening-remarks-at-the-boe-independence-20-years-on-conference.pdf [accessed: 5 July 2021]
2 The inflation target was originally 2.5% measured by RPIX. It was changed to 2% measured by CPI in 2003.
3 The Governor is also required to explain the outlook for inflation and the reasons why inflation has moved away from the target; the policy action the committee is taking in response; the horizon over which the committee judges it is appropriate to return inflation to the target; the trade-off that has been made with regard to inflation and output variability in determining the scale and duration of any expected deviation of inflation from the target; how this approach meets the government’s monetary policy objectives.
5 In the UK, the overwhelming majority of assets bought by the Bank of England are Government bonds. By the end of 2021, the Bank has said it will have purchased £875 billion in Government bonds compared to £20 billion in corporate bonds.
6 Bonds are a type of investment whereby investors lend money to the Government (UK Government bonds are also called ‘gilts’) or to a private company in return for interest. The bond issuer (for example, the Government) pays the holder of the bond a rate of interest, known as the ‘coupon’, until the ‘maturity’ date when the issuer is obliged to repay the value of the bond to the bond holder. The return that a bondholder receives on their investment is called the yield. Bonds can be resold to other investors on the ‘secondary market’. If the price of a bond has increased then the yield will be lower, as investors are paying more for a given bond to receive the same coupon price. Correspondingly, if a bond price falls the yield rises.
7 New Economics Foundation, Strategic quantitative easing: Stimulating investment to rebalance the economy (1 July 2013): https://neweconomics.org/uploads/files/e79789e1e31f261e95_ypm6b49z7.pdf [accessed 5 July 2021]
8 For example, Bank of England, Minutes of the Monetary Policy Committee meeting, 4 and 5 March 2009, (18 March 2009): https://www.bankofengland.co.uk/-/media/boe/files/minutes/2009/minutes-march-2009.pdf [accessed 5 July 2021]
9 House of Commons Library, Quantitative Easing, Debate Pack, CDP 2016/0166, 14 September 2016, p 4 [accessed 5 July 2021]
10 Bank of England, Monetary Policy Summary and minutes of the Monetary Policy Committee meeting ending on 3 August 2016 (4 August 2016): https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2016/august-2016.pdf [accessed 5 July 2021]
11 Bank of England, Minutes of the special Monetary Policy Committee meeting on 19 March 2020 and the Monetary Policy Committee meeting ending on 25 March 2020 (26 March 2020): https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2020/march-2020.pdf [accessed 5 July 2021], see also Bank of England, Monetary Policy Summary and minutes of the Monetary Policy Committee meeting ending on 17 June 2020 (18 June 2020): https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2020/june-2020.pdf [accessed 5 July 2021] and Bank of England, Monetary Policy Summary and minutes of the Monetary Policy Committee meeting ending on 4 November 2020 (5 November 2020): https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2020/november-2020.pdf [accessed 5 July 2021]
12 Written evidence from the Bank of England (QEI0015) and Bank of England, ‘IEO evaluation of the Bank of England’s approach to quantitative easing’ (13 January 2021) : https://www.bankofengland.co.uk/independent-evaluation-office/ieo-report-january-2021/ieo-evaluation-of-the-bank-of-englands-approach-to-quantitative-easing [accessed 5 July 2021]
14 Andy Haldane, speech on What Has Central Bank Independence Ever Done for Us?, 28 November 2020: https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/what-has-central-bank-independence-ever-done-for-us-speech-by-andy-haldane.pdf [accessed 5 July 2021]